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SolarCity's Dominance Could Be Threatened in a Very Serious Way

SolarCity (NASDAQ: SCTY) has risen to dominance in the residential solar industry and built a $6 billion market cap in the process. It's done this by expanding more aggressively and offering innovative financing to customers than any other installer.

The company competes against mom-and-pop shops, multinational corporations, and everything in between in a very fragmented business. The challenge for SolarCity's continued growth is keeping the sales channel full of high value residential solar projects. If it can do that, the sky's the limit for the company. But as competitors emerge, I see a threat forming -- the biggest one SolarCity has faced yet.

Logo courtesy of SolarCity.

Competitors emerging SolarCity has built an incredible 32% market share in the residential solar market, and outside of that, there's no one who has more than a 10% share. But there are an increasing number of large companies looking at getting into the business and they have the expertise and balance sheets that should concern SolarCity.

First, you have early movers in residential solar like Sunrun, Clean Power Finance, and SunPower (NASDAQ: SPWR) , which provide financing and other services but work with dealers to do the actual installation. These are the immediate threat, but it's when utilities get involved that this business gets interesting.

The latest trend is for utilities to get into solar by forming a fund and then selling residential systems directly to customers. This is what Integrys Energy Group (NYSE: TEG) is doing with a fund it recently launched with Clean Power Finance's online platform. Integrys is providing the funding and the sales channel while Clean Power Finance provides bidding tools and installation partners to build the residential solar systems.

Integrys isn't the only utility looking into solar. EdisonInternational (NYSE: EIX) and Duke Energy (NYSE: DUK) both invested equity in Clean Power Finance, along with two unnamed utilities. Utilities are also beginning to start funds similar to Integrys' to finance and sell solar projects, although they've remained largely silent so far. These are well-funded utilities with sales channels SolarCity doesn't have. They already have a point of contact with millions of customers around the country, and if they can figure out a way to sell residential solar effectively they could become huge competitors.

Rooftop installations done by SolarCity. Image courtesy of SolarCity.

SolarCity sees the challenge coming Don't think SolarCity doesn't see the competition coming. There's a reason it offered to pay $120 million for Paramount Solar last year, adding essentially a telemarketing sales channel to its efforts. It also partnered with Home Depot to add a retail-sales channel and made the recent announcement that it will offer ways for individuals and small institutions to invest in solar. SolarCity is building as many sales channels as possible, hoping to reach customers before someone else does.

But SolarCity doesn't have a natural way to reach customers like a utility does, hence the door-to-door and phone-call sales. Utilities have a point of contact at least once a month when customers pay their bills, and they can offer solar without adding a new bill to pay. If utilities can leverage that contact to install solar on rooftops and in turn own the systems it'll be a significant competitor.

The one thing that will keep utilities or other competitors from encroaching on SolarCity's business is having a national scale and product offerings (like the new online-investing marketplace) that a utility doesn't have, and that's why these strategic acquisitions have been made over the past year.

The biggest long-term threat For now, there aren't many utilities, if any, who can efficiently compete with SolarCity in selling or installing solar. But remember that the utilities are just getting started, and California and Arizona account for a vast majority of solar installations right now, and that's where SolarCity has a huge head start. But the dynamic could change quickly as states like New York, Massachusetts, Texas, and others grow and utilities figure out ways to invest in solar.

Of course, there's no guarantee utilities will get solar right and take any share. Keep an eye on SolarCity's market share as well as how utilities attack the solar market in coming years to see if competitors are making inroads. If either market share or value per watt installed falls, it'll be a sign competition is heating up.

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Fool contributor Travis Hoium manages an account that owns shares of SunPower and personally owns shares and has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 calls on SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Comments from our Foolish Readers

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Travis is right. We're a small player that has nationwide exposure due to the number of prominent websites that we control. We have a growing list of experienced installation contractors in nearly every state and offer comprehensive support to the DIY community.

Our per client acquisition costs is mere pennies. We offer an advanced residential PV system that uses American made solar modules versus SolarCity's Chinese/Foreign solar modules at nearly 1/3 the cost of a $0 down solar lease. Even less that 1/3 the cost if you factor in the leasing company's annual payment escalator.

We offer $0 down loans that offer a better return than any lease or PPA. We close nearly 97% of the clients that have been exposed to the solar lease or PPA sales pitch.

We have been in the residential PV market since 1997 and offer a PV module that outperforms over 100 of SunPower's module models with a better PTC to STC ratio at nearly half the cost.

We're nobody today, compared to SolarCity but SolarCity was nobody back in 2007. For us, the last step is simply a matter of turning up the volume on our low cost marketing, 2014 will be the year for change in the solar industry. I guaranty it.

Don't expect your friendly neighborhood utility company to be very aggressive in selling you a rooftop solar power system. They'll do it as a compliance measure to meet whatever local mandates might be in effect, but it's basically not in their best interests to switch their own customer base to solar power. They're more likely to lobby intensely to rid themselves of any such mandate as well as any subsidies for rooftop solar. They have also started to lobby to pass on more of the costs of distribution to solar customers with grid connections. They're basically sitting ducks for whoever can sell into their customer base at a lower price than they can.

I can see competition coming. But I have been reading about Elon Musk and he is bringing the same high-tech competitive style to the engineering industry as once did Bill Gates and crushed competitors. The slow motion, old mentality car industry and solar panel industry are not used to it. Unless competitors find an equally savvy CEO, I am afraid they need to be prepared themselves for a supreme beating.

I agree their is competition... But I think what you fail to realize HOw little solar has penetrated the market. Yes lets say scty loses shares from 30% and eventually get down to 15%... but remember solar only represents 1% of renewable energy.... yeah so scty loses 1/2 but that penetrance will be closer to the 10% market.

In other words... Id rather be 20% of a market share thats worth 100 billion than be 50% of a market valued at 30 billion.

Solar City has not perfected the art of selling solar as a Home Improvement, but rather as a technology. This is their biggest threat to the stock price moving forward. Companies like American Solar Direct﻿ have figured this out and are charging forward in market share quickly

This article, and many of the comments, sounds like the those written about how the old Bell System (the old AT&T) was going to crush all of those new entrants authorized by the FCC and the courts. NOT! The entrenched electric utilities' strategies will be to protect the huge investments they have in old technologies. They may move to adopt the new, but it will be too slow to cope with competitors not fettered by the need to produce a return on enormous investments that are increasingly obsolete.